What defines compound interest?

Compound interest is defined as interest that is calculated on the initial principal, which also includes all of the accumulated interest from previous periods. This means that, as time passes, the interest builds upon itself, which can lead to significant growth of the investment or loan over time.

For example, if you invest a certain sum of money, the interest for the first period is calculated on that initial amount. However, during the next period, the interest calculation will be based not just on the initial principal, but also on the interest that has already been added to it. This serves to amplify the effects of interest growth, exemplifying the power of compound interest compared to simple interest, which only considers the principal amount.

This mechanism is fundamental to many financial calculations and investments, as it demonstrates how investments can grow exponentially over time due to the compounding effect.